There's no magic pill to battle the bear market, but there are some strategies that could keep the bear at bay.
As any financial planner will tell you, the key to keeping your head above water in a bear market is a diversified portfolio. Depending on your age and risk tolerance, planners normally advise investors to keep a certain amount of their portfolios in bonds and cash and a certain amount in stocks or stock funds, normally with a representative mix of different market capitalizations and industries.
But are there any mutual funds that can withstand the bearishness? Probably not on their own, but pundits say small doses of funds that invest in assets that normally move in the opposite direction of stocks or independent of what is happening in the market can make for a good hedging tool in a diversified portfolio.
The most obvious funds that come to mind are bear market funds such as the aptly named
Prudent Bear, the
ProFunds Bear and the
Rydex Ursa funds.
These funds bet on a market decline by shorting stocks or index futures and so normally move in the opposite direction of the general market. Although that strategy proved effective during the stock market's selloff last year, these funds have also missed out on the stellar returns of the bull market. That, coupled with high expense ratios, makes these funds suitable for, at most, a small part of investors' portfolios, say analysts.
The same caveat applies to other funds that short the market, like
series of short funds, which aim to get the opposite returns of the
Dow Jones Composite Internet
"Funds that are just pure short I would steer clear of, simply because over time, stocks go up and you really don't want much money tied up with shorts," says
director of fund analysis Russ Kinnel. "On top of that, people always time these things wrong."
Another brand of equity mutual fund that is supposed to return steady gains no matter what the market does is the market neutral fund. Managers of market neutral funds try to keep returns at a consistent 10% by making long-term bets on undervalued stocks they think are on the way up, while simultaneously shorting overvalued stocks they think are headed for a fall. The theory is that no matter what the market does, the fund should do OK as long as the manager picks the right stocks.
The problem with many of these funds is that they haven't been able to practice what they preach. A screen of market neutral funds shows lackluster returns for most funds in the category, with the exception of the
Merger fund, a unique fund that invests in companies involved in merger activity. M&A funds like Merger work similarly to market neutral funds in that the manager will buy stock in the company being acquired with the expectation that its price will rise before the deal closes and will short the stock or the acquiring company with the opposite expectation.
Another market neutral fund that Kinnel says has held up relatively well over the years is the
Calamos Market Neutral fund, which shorts the underlying common stocks of the convertible securities it owns. But he's not bullish on most funds of this genre.
"The vast majority of market neutral funds I wouldn't touch," says Kinnel. "It wouldn't be worth the opportunity costs, and most of them seem to be lousy performers."
Another potential "hedge" for mutual fund investors is the
Oppenheimer Real Asset fund, a fund that is favored by certified financial planner Harold Evensky in tough times. This fund gives investors commodity exposure because it buys securities that mimic the returns of commodities, using the
Goldman Sachs Commodity Index
as its benchmark. The planner says he'll put no more than 5% of a client's portfolio in this fund for diversification.
"It tends to move in a direction opposite stocks and bonds," says Evensky. "It's an extremely good hedge, and we invest in it to reduce risk."
Certain asset classes, such as real estate, are also commonly mentioned as alternative investments because they often move in the opposite direction of the market, according to Morningstar's Kinnel. In the past 12-month period, for example, real estate funds have gained a respectable 22.35%, while the S&P 500 has dropped 6.88%.
The caveat to investing in real estate is that it is not foolproof. If the U.S. economy is headed for a recession, real estate prices could plummet along with the stock market.
"Real estate worked very nicely last year," says Kinnel. "But you can certainly imagine that if we go into recession this year, it will hit real estate as much as everything else."
Of course, good old-fashioned balanced, or hybrid, funds can also provide investors with diversity in one shot. These funds, which typically have roughly a 70% to 30% ratio of stocks to bonds, are an automatic way to diversify. Plus, if an investor is particularly skittish about the market, he or she can choose a balanced fund with a particularly large bond component or one comprised mostly of Treasury bonds or government agency securities.
Because there are tons of hybrid funds out there, Barry Vosler, a certified financial planner based in DeWitt, Iowa, suggests that investors look at funds that have been around at least 10 years and that have performed well throughout the market's rough patches. Vosler's favorite balanced funds include
Pax World Balanced,
MFS Total Return and the
Income Fund of America.
Diahann Lassus, a New Providence, N.J.-based certified financial planner, says she's looking at value funds, which invest in stocks that have been beaten up by the market, for this environment. Her favorites include
Dodge & Cox Stock and
Neuberger Berman Focus.
Lassus' other strategies for a bear market include ramping up the bond portion of your portfolio, depending on how soon you need the cash on hand. An investor who will need cash in the next few years should have a higher proportion of his portfolio in cash and bonds, says Lassus.
Above all, Lassus recommends that no matter how bad the market looks, investors should stay invested in order to reap the rewards when the market inevitably turns itself around.
"Even going into a bear market, you still have to maintain some level of investment portfolio," says Lassus. "Otherwise, when we come out of it, it happens so quickly that you miss out on some of the gains."